Sunday, September 16, 2007

What is Decoupling and Has It Happened?

The following from Bloomberg discusses the concept of de-coupling. That is, economies in other countries are sufficiently independent of the US so if the US economy slips into a recession the other economies will be largely unaffected. Nice try, but no cigar yet. From Bloomberg:

Decoupling, the notion that the rest of the world can weather the effects of a slowing U.S. economy, had all the attributes of a successful advertising campaign. The message was simple, clear and succinct.

One problem: It doesn't fly, or at least not yet. It might even be argued that the powerful forces of globalization make decoupling impossible.

``Global growth will decouple from U.S. growth to a greater extent than in the past,'' Goldman Sachs Group Inc. said in a September 2006 report by Jim O'Neill, head of economic research.
The U.S. is now a less important destination for world exports, the firm said. ``Domestic demand is on solid footing in Europe, Japan and key emerging markets,'' Goldman said. ``The underlying shock driving the U.S. slowdown is not global in nature but is linked to a slowing U.S. housing market.''

``A sharp slowdown in the U.S. economy in 2007 is unlikely to drag the rest of the global economy down with it,'' Merrill Lynch & Co. said last year. ``The good news is that there are strong sources of growth outside the U.S. that should prove resilient to a consumer-led U.S. slowdown.''

The firm dismissed the potential fallout from a U.S. housing downturn with a simple, ``The world doesn't build U.S. houses.''

Both Goldman Sachs and Merrill Lynch were bullish on Japan. ``Global star,'' Merrill called Asia's largest economy. ``Japan appears better able to withstand a U.S. slowdown than any other country.''

As for the 13-nation euro area, Merrill said, ``The region has a good chance of avoiding the worst effects of a U.S. slowdown.''

Now for the reality check.

Japan's gross domestic product contracted an annualized 1.2 percent in the second quarter, down from 3 percent in the first quarter and 5.6 percent in the fourth quarter of 2006.

Meanwhile, euro-area GDP growth was a weak 0.3 percent in the second quarter, down from an average of 0.8 percent for each of the preceding two quarters and the lowest since the last three months of 2004.

Among the euro area's bigger economies, German GDP slowed to 0.3 percent in the April-June period, down from 0.5 percent in the first quarter. Business confidence in Germany also fell to a 10-month low in August as the cost of credit increased. French GDP was also 0.3 percent, while Italy grew a measly 0.1 percent.

Elsewhere, the U.K. housing boom is ending, and the Mexican peso is set to weaken as remittances from Mexicans abroad -- especially the U.S. -- slow down, London-based Lombard Street Research Ltd. predicted earlier this month. Central bankers have been no more accurate than their private-sector brethren in reading the economic tea leaves.

``Strong money supply, driven by buoyant credit demand, adds to concerns that consumer-price increases in the euro area will stay on average significantly above 2 percent in coming years,'' Germany's Bundesbank said in its monthly bulletin, which was completed at 11 a.m. on Aug. 17.

Duh! That was after central banks had pumped $350 billion of emergency funding into global money markets and just hours before the Federal Reserve cut its discount rate.

For months, the return of inflation and the need for central banks to resist it with higher interest rates were a concern. The real risk, though, is deflation, compliments of the U.S. subprime mortgage mess and tightening credit standards.

``Amid all the fear generated by the U.S. subprime meltdown, one key argument against the `sky-is-falling' camp rested with the assumption that while the U.S. economy may be vulnerable to a credit shock, the rest of the world was doing just fine,'' says Joseph Quinlan, New York-based chief market strategist at Bank of America Capital Management.

Well, last week, concerns that the market turmoil may spread persuaded central banks in Europe, the U.K., Australia, Canada and South Korea to hold off raising rates.

On Sept. 10, Morgan Stanley economists lowered their 2008 U.S. growth forecast to 2 percent from 2.6 percent and, as a consequence, cut their projection of 2008 euro-area GDP growth to 2 percent from 2.4 percent.

``The U.S. economy is and should continue to be weaker than we had expected, as the housing-market downturn starts to spill over on the economy at large,'' says Eric Chaney, the firm's London-based chief European economist. And Morgan Stanley was never a card-carrying member of the decoupling camp.

Decoupling proponents back their claims with data. Yet markets were overcome by banks' hesitancy to extend credit to anybody they didn't trust, which for a while was just about everybody. The benign financial conditions that everyone depended on suddenly became less benign.

Not all decoupling advocates are giving up. Asian countries' dependence on the U.S. consumer has declined ``dramatically'' since the technology bubble burst, says Silvia Liu, a Hong Kong- based economist at Merrill Lynch. Exports of consumer goods to the U.S. declined to 6 percent of total Asian exports in 2006 from 8 percent in 2001, she says.

Goldman Sachs economists reiterated their confidence in decoupling in a Sept. 12 report, using the same arguments as a year ago, adding that the so-called BRIC countries -- Brazil, Russia, India and China -- remain ``key to global decoupling.''

The day will come when the rest of the world can escape the pull of the $13.3 trillion U.S. economy, especially when the BRIC nations mature. (my emphasis)

For the time being, though, it's too soon to count the Americans out.

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